The Nasdaq 100​ sold off nearly 2.5% at the end of last week, while the Powershares QQQ Trust (QQQ) posted its highest volume day since the August 2015 mini flash crash. Those bearish metrics generated a major distribution day that's likely to yield a summer correction, testing gains posted since the November breakout. Traders and market timers should take defensive actions as soon as possible to protect gains and prepare for opportunities triggered by sharply lower stock prices.

The tech-heavy index posted six straight months of higher prices into last week, setting off extremely over-bought technical readings that may require months of profit taking to shake out complacency and set the stage for a strong 2017 close. However, it was not a typical downtrend day because a good chunk of capital exiting big winners like Amazon.com, Inc. (AMZN), Alphabet Inc. (GOOGL) and NVIDIA Corporation (NVDA) rotated into market groups that have underperformed in recent months. (See also: The Top 4 ETFs to Track the Nasdaq.)

Let's look at three ways to trade and survive a summer correction, with a narrow focus on aggressive risk management, shorter holding periods and well timed short sales. Countertrends​ can unfold quickly through a series of sharp down days or evolve through two-sided action that persists for weeks or months before reaching the deep lows needed to institute new long-term positions. These time-tested techniques should work with both scenarios. 

Raise Cash

The over-loved and overbought technology sector now holds a large supply of weak-handed players that are likely to panic when the market heads lower because they've been conditioned by Wall Street to hold for the long term but don't have the discipline to follow that advice. It is often better to be the first one out the door, raising cash that can be used for short-term trades or to buy back beloved issues at much lower prices. This follows the old trader's wisdom to "buy 'em when they're cryin' and sell 'em when they yellin'." (For more, see Tech Stocks May Be Both Cheap – and Risky.)

Don't Try to Pick a Bottom

 

The Nasdaq 100 set off a weekly-scale Stochastics sell signal last week, raising the odds for bearish price action that lasts between eight and 12 weeks. It is best to avoid bottom fishing until the indicator reaches the oversold zone while concentrating firepower on relative lows that generate buy signals on the 60-minute chart. Once positioned, it's important to sell aggressively when bounces reach short-term resistance levels that are likely to attract fresh selling pressure. Those levels also mark entry zones for carefully timed short sales that should be covered aggressively during breakdowns and wide-range sell-off days.  

Play the Rotation

 

Banks, industrial metals, energy, retail and small caps closed Friday's session higher or near their unchanged levels, putting a floor under the S&P 500, but it will take weeks or months for those laggards to provide steady leadership rather than hours or days. As a result, these sectors are more likely to offer well timed position trades than longer-term investments, at least through the summer months. (For more, check out Sector Rotation: The Essentials.)   

Banks are best positioned to take advance of a positive rotation after a three-month decline that dropped SPDR S&P Bank ETF (KBE) into deep support at the 200-day EMA. Last week's buying surge has already reached short-term resistance, setting up two possible trading scenarios. First, a consolidation near the April high at 44 will set off fresh buy signals if it can hold that level for one to two weeks. Alternatively, a pullback that tests the 50-day EMA at 42.50 should also be buyable, ahead of continued upside into the March high.

The Bottom Line

The Nasdaq 100 posted the highest selling volume since August 2015 on June 9, signaling the start of a summer correction that will shake out high levels of complacency. Market players that adapt quickly can take advantage of this downturn, avoiding the typical traps that can empty trading and investment accounts. (For related reading, check out Why a 10% Stock Correction May Be Good.)

<Disclosure: the author held no positions in aforementioned stocks or funds at the time of publication.>

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.